The leading economies of the industrialized nations may not have a lot in common, but they are all afflicted by this: Inflation is too low.
That was the astoundingly consistent theme out of a range of data released Thursday. Prices rose 1.1 percent over the 12 months that ended in April in Germany, 0.8 percent in France and 1.3 percent in Italy. In the United States, the consumer price index rose 1.1 percent over the last year. Japan reported surprisingly strong first-quarter growth this week as its aggressive new stimulus policies took effect, but that came against a backdrop of continued falling prices; its consumer price index fell 0.9 percent in the year that ended in March.
The leading central banks at this point are all unified on this: 2 percent is the amount of annual inflation they are aiming for. And they are all failing in that mission, and nearly all failing in the same direction (Britain is the notable exception; prices there rose 2.8 percent over the year that ended in March, the most recent data available).
The below-trend inflation is partly attributable to falling commodities prices, and just as policy shouldn’t overreact when a short-term commodity blip causes inflation, it shouldn’t make the same mistake in reverse. But even excluding food and energy, U.S. CPI was up only 1.7 percent, still below the level of inflation the Federal Reserve is aiming for. And the situation in Europe is particularly worrisome; if the euro zone is going to have any hope of rebalancing its economy without a prolonged depression, it will need higher inflation in core European countries like Germany and France, offset by lower inflation in countries like Greece and Spain. Instead, prices are rising too slowly even in the core, and there is deflation, or falling prices, in Greece.
The biggest conclusion to draw from all of this is that warnings that massive quantitative easing efforts would spark explosive inflation are turning out to be as wrongheaded as can be. In the United States and Japan, central banks now have open-ended policies of printing money to buy assets. But while the money seems to be finding its way into asset markets, such as for stocks and corporate debt, it isn’t being circulated so widely as to drive up prices for consumers.
This is the opposite of what the currency war alarmists have warned about. Instead of creating rounds of vicious inflation while trying to expand the money supply in a race to the bottom, central banks are all trying to get inflation up to their target and coming up short. Deflation is looking like a greater risk that inflation, despite the extensive hand-wringing over the latter in the last several years. It’s a currency war in which almost every country is losing.
There’s some positive news in the low inflation numbers, particularly in the United States. The composition of the newest CPI report was quite hopeful: Falling gas prices (down 8.1 percent in April) leave consumers with more money to spend on everything else. And -- this is crucial -- inflation expectations seem to be well-anchored at almost precisely the Fed’s target. Bond prices suggest that investors expect annual inflation over the coming five years to average 2.003 percent.
If global inflation is the dog that won’t bite, and large chunks of the world economy remain depressed, it is a moment for some reflection. The 2 percent inflation target that has been adopted by the major world central banks is, to a large degree, arbitrary. It’s low enough that prices feel stable, yet high enough that when there is an economic slump, the central bank can end it by achieving negative real interest rates (that is, it can push interest rates to zero at a time of 2 percent inflation, resulting in a negative 2 percent inflation-adjusted interest rate).
But the apparent impotence of the central bankers to achieve that 2 percent inflation in the last few years makes us question if it is too low to begin with. If they had anchored expectations at 2.5 or 3 percent, they would have had more room to adjust short-term rates to help the economy before entering the world of quantitative easing, where even trillions of dollars and yen seem to have precious little effect on the real economy.
For now, Americans can enjoy the benefits of cheaper gasoline, and the Fed can pat itself on the back for keeping expectations for future inflation stable. But that doesn’t mean the situation we find ourselves in is one to be particularly proud of.